Known economic indicators are being peered over more closely as recession risks whirl around the US economy. Sahm Consulting Founder Claudia Sahm joins Yahoo Finance Live as part of its Chartbook series to discuss the labor market and the "Sahm Rule" named after her, which is said to measure whether a recession is ahead or not.

According to the former Federal Reserve Board economist, the rule states that an indicator of a recession is a “three-month moving average of national unemployment relative to its low during the previous twelve months.” Sahm states that based on the rule, currently “we are not in a recession.”

Taking a closer look at the labor market, Sam notes that there were “a lot of disruptions,” and stabilization “takes time.” Sahm believes that although the Federal Reserve is “dragging their feet,” a rate cut is to be expected. Sahm expects the Fed to be cautious but predicts that believers in early-March interest rate cuts will be “disappointed," ahead of the Fed announcement on Wednesday, January 31.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Eyek Ntekim

Video Transcript

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JOSH LIPTON: This week, Yahoo Finance's taking a look at key charts from the top minds on Wall Street as part of our chart book series. And this hour, we're looking at the labor market. Here with me now Claudia Sahm, former Fed economist and Sahm Consulting founder. And the reporter behind the Yahoo Finance chart book, the one and only Josh Schafer.

Claudia, it is great to see you and have you on the show here today, Claudia. I thought maybe to start, Claudia, you could walk our viewers through what exactly is the Sahm rule, Claudia? And what's it telling us right now about the US economy?

CLAUDIA SAHM: The Sahm rule is a way to say, hey, are we in a recession or not? So it's an indicator. It doesn't forecast anything. And I'm very happy to report that it is in a good place. We are not in a recession.

Now, the Sahm rule, the idea of it is it looks at the national unemployment rate. That really tells us a lot about how the economy is doing. And in particular for a recession indicator, we look for relatively small changes over time in the unemployment rate. Because usually when things get going, they keep going and a bad way with the recession.

And you can see with the chart, this is the Sahm rule. So it looks at the three-month average of the unemployment rate. We smooth out the bumps and wiggles. Where we at now versus what's the lowest over the prior year, that's what it's charting. And every time we go into a recession, it has gotten above a half a percentage point and then kept going. And right now it's about 2/10 percentage point, so we are not in a recession.

JOSH SCHAFER: And Claudia, the Sahm rule was certainly something that people like to talk about a lot, specifically maybe this fall. I think it was around November, a lot of people were highlighting is this sort of when the uptick in unemployment comes? As you noted, it never really did come. I'm curious what dynamics you're just seeing in the labor market right now that has kept the unemployment rate so low?

CLAUDIA SAHM: We did see the unemployment rate drift up, but it had been in a very low 3.5% last summer. And by the fall, by the end of the year, we were up around 3.7%. So that is higher, but a pretty small increase.

What's been happening in the labor market, and you can look across all different kinds of metrics, is we had a lot of disruptions. And we've been trying to rebalance and it's happening. It's just it takes time, right?

We have very good developments with a lot more people coming into the labor force, particularly immigrant workers. It took some time to match them up with jobs, so the unemployment rate drifted up for a little bit. But we needed those workers, so that's good. So we're still just working through a lot of disruptions and I and everyone else is keeping an eye on that labor market to make sure that it's rebalanced and not slowing in a way that could really go downhill.

JOSH LIPTON: And Claudia, as you look out across 2024, I am just interested your expectations for the labor market, Claudia. What do you think the trajectory looks like there?

CLAUDIA SAHM: It's good. The outlook is good. And for the past two years, I have said repeatedly that a soft landing, meaning we get inflation back to 2% and we keep unemployment low, it is entirely possible. That's been my base case.

And we can see the landing. I mean, we are getting so close to this. And an absolute key part of this has been a strong labor market and with that American consumers out there spending.

JOSH SCHAFER: Claudia, how big of a role does the Fed's path play in that? Because I'd imagine if the Fed were to keep rates for a little bit higher here, maybe longer than some expect, maybe not, they don't cut in May-- or sorry, they don't cut in March or they don't cut in May, at some point is that going to have an impact on what we're seeing in the labor market?

CLAUDIA SAHM: It's highly likely. I mean, it should. The Federal Reserve is putting a lot of pressure on the economy. And interest rates are legitimately high relative to where they were before the pandemic and probably where they should be when things are just neutral and the Fed isn't doing anything.

So the labor market is strong. The consumers are strong. But that doesn't mean it stays that way.

And the Fed has said they're going to start cutting. They're kind of dragging their feet, but they're going to do the right thing in the end. It's just we need everything to hold together to get back to that fully rebalanced place. And that involves the Fed being back with lower interest rates.

JOSH SCHAFER: So Claudia, with that in mind, I mean, what do you listening for in Chair Powell's press conference tomorrow and maybe even in subsequent comments from the Fed moving forward?

CLAUDIA SAHM: My biggest goal for tomorrow is to go in and really fight my confirmation bias. And I think everybody should because the Fed and Jay Powell at the press conference will be very cagey and very vague. And we'll all have a tendency to go hear what we want to hear.

I certainly think they should be cutting. I do not expect them to be cutting until May. And so I got to really listen to what he's saying.

They're going to open a lot of doors in terms of when they'll cut, but they're going to signal very strongly as have Fed officials speaking in recent weeks. They're going to be cautious. They really, really need to see a lot with inflation. So I don't think-- people who are thinking May-- or I'm sorry, thinking March and it's soon, I think they might be disappointed tomorrow if they really listen closely to what Jay has to say.

JOSH LIPTON: All right, we'll all be listening closely to what Jay has to say. Claudia, thank you so much for joining us today. And our thanks again to our own Josh Schafer as well.